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Hedging Update — ETFs

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The Chicago Board Options Exchange Market Volatility Index (VIX) rose 4.47% Thursday, to close at 20.80. The table below shows the costs, as of Thursday's close, of hedging 18 of the 20 most actively-traded ETFs against greater-than-20% declines over the next several months, using the optimal puts for that. First, a reminder about what optimal puts mean in this context, and why I've used 20% as a decline threshold.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web, and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own, and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones (there's an example of this, with screen shots, in this article).

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary in October 2008: 

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

How Costs Are Calculated

To be conservative, Portfolio Armor calculated the costs below based on the ask prices of the optimal put options. In practice, though, an investor may be able to buy some of these put options for less (i.e., at a price between the bid and the ask).

Why There Were No Optimal Puts for TZA and FAZ

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with the Direxion Small Cap Bear 3X (TZA) and the Direxion Daily Financial Bear 3X (FAZ). As of Thursday's close, the cost of protecting against greater-than-20% declines in those ETFs over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for them.

Hedging costs as of Thursday

The data in the table below is as of Thursday's close. The ETFs are listed in order trading volume Thursday, with the most actively-traded name (SPY) at the top.

Symbol

Name

Cost of Protection (as % of position value)

SPY

SPDR S&P 500

1.80%*
XLF Financial Select Sector SPDR 3.23%*
QQQ QQQ Trust 2.68%*
IWM iShares Russell 2000 Index 2.93%*
SLV iShares Silver Trust 5.05%*
EEM iShares MSCI Emerging Markets 2.80%*
EWJ iShares MSCI Japan 1.89%*
FAS Direxion Financial Bear 3X 17.31%*
SDS ProShares Ultra Short S&P 500 4.12%*
VWO Vanguard MSCI Emerging MKTS 3.48%*
EFA iShares MSCI EAFE Index 3.12%*
TZA Direxion Small Cap Bear 3X No Optimal Puts
XLE Select Sector SPDR — Energy 3.10%*
FXI iShares FTSE China 25 Index 2.94%*
XLI Industrial Select Sector SPDR 2.03%*
SSO ProShares Ultra S&P 500 7.30%*
GLD SPDR Gold Shares 0.43%*
SMH Semiconductor HOLDRs 4.87%*
GDX Market Vectors Gold Miners 4.03%*
FAZ Direxion Daily Financial Bear 3X No Optimal Puts

*Based on optimal puts expiring in January, 2012.

Hedging Update — Stocks

By -

The Chicago Board Options Exchange Market Volatility Index (VIX) ticked up 8.05% Tuesday to close at 19.87. The table below shows the costs, as of Tuesday's close, of hedging 19 of the 20 of the most actively-traded stocks against greater-than-20% declines over the next several months, using the optimal puts for that.

Comparisons

For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (SPY), the SPDR Dow Jones Industrial Average ETF (DIA) and the Nasdaq 100-tracking ETF PowerShares QQQ Trust ETF (QQQ) against the similar declines. First, a reminder about what optimal puts mean in this context and why I've used 20% as a decline threshold.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones (there's an example of this, with screenshots, in this article about hedging against a US default with puts on TLT).

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary in October 2008:

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

How Costs Are Calculated

To be conservative, Portfolio Armor calculated the costs below based on the ask prices of the optimal put options. In practice, though, an investor may be able to buy some of these put options for less (i.e., at a price between the bid and the ask).

Why There Were No Optimal Puts for RADS

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with Radiant Systems Inc. (RADS). As of Tuesday, the cost of protecting against a greater-than-20% decline in that stock over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for it.

Hedging Costs as of Tuesday's close

The data in the table below is as of Tuesday's close. After the three ETFs listed for comparison purposes, the NYSE stocks are listed in order of their share volume in Tuesday's trading, with the most actively traded stock (MI) listed first; the Nasdaq stocks are listed in a similar order, with the most actively traded Nasdaq stock (NWSA) listed first.

Symbol

Name

Cost of Protection (as % of position value)
  Comparison Index ETFs  

SPY

SPDR S&P 500

1.71%*
DIA SPDR Dow Jones Industrial Avg 1.55%*
QQQ PowerShares QQQ Trust 2.49%*
  NYSE Stocks  
BAC Bank of America Corporation 5.78%*
NLY Annaly Capital Management 1.83%*
F Ford 3.58%*
GE General Electric Company 3.43%*
C Citigroup Inc. 3.99%*
PFE Pfizer Inc. 2.95%*
AMD Advanced Micro Devices, Inc. 9.64%*
MGM MGM Resorts International 12.2%*
AA Alcoa, Inc. 5.03%*
JPM JP Morgan Chase & Co. 3.15%*
  Nasdaq Stocks  
NWSA News Corporation 6.51%*
CSCO Cisco Systems, Inc. 4.17%*
QQQ PowerShares QQQ 2.49%*
INTC Intel Corporation 2.94%*
SIRI Sirius XM Radio Inc. 11.0%*
MSFT Microsoft Corporation 2.49%*
ORCL Oracle Corp. 3.56%*
RADS Radiant Systems Inc. No Optimal Puts At This Threshold
MU Micron Technologies 12.1%*
AMAT Applied Materials Inc. 4.43%*

*Based on optimal puts expiring in January, 2012.

Hedging Update — ETFs

By -

The Chicago Board Options Exchange Market Volatility Index (VIX) dropped 2.39% Thursday, to close at 15.95. The table below shows the costs, as of Thursday's close, of hedging the 20 most actively-traded ETFs against greater-than-20% declines over the next several months, using the optimal puts for that. First, a reminder about why I've used 20% as a decline threshold and what optimal puts mean in this context.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web, and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own, and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones (there's an example of this, with screen shots, in this recent article regarding the last ETF in the table below, TLT).

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary in October 2008: 

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

How Costs Are Calculated

To be conservative, Portfolio Armor calculated the costs below based on the ask prices of the optimal put options. In practice, though, an investor may be able to buy some of these put options for less (i.e., at a price between the bid and the ask).

Hedging costs as of Thursday

The data in the table below is as of Thursday's close. The ETFs are listed in order trading volume Thursday, with the most actively-traded name (SPY) at the top.

Symbol

Name

Cost of Protection (as % of position value)

SPY

SPDR S&P 500

1.10%*
IWM iShares Russell 2000 Index 2.25%*
EWJ iShares MSCI Japan 1.78%*
EEM iShares MSCI Emerging Markets 2.25%*
XLF Financial Select Sector SPDR 1.92%*
XLI Industrial Select Sector SPDR 1.85%*
XLE Select Sector SPDR — Energy 2.10%*
EFA iShares MSCI EAFE Index 2.03%*
EWZ iShares MSCI Brazil Index 3.86%*
USO United States Oil 3.52%*
XLK Technology Select Sector SPDR 1.39%*
SMH Semiconductor HOLDRs 2.42%*
XLB Materials Select Sector SPDR 2.66%*
EWT iShares MSCI Taiwan Index 2.61%*
IYR iShares Dow Jones Real Estate 1.92%*
XLU Utilities Select Sector SPDR 0.97%*
XLY Consumer Discretionary SPDR 1.59%*
XLV Health Care Select SPDR 1.11%*
XLP Consumer Staples Select SPDR 0.75%*
TLT iShares Barclays 20+ Yr. Treas. 0.74%*

*Based on optimal puts expiring in January, 2012.

Hedging Update — Stocks

By -

The Chicago Board Options Exchange Market Volatility Index (VIX) ticked up 1.2% Tuesday to close at 16.06. The table below shows the costs, as of Tuesday's close, of hedging 19 of the 20 of the most actively-traded stocks against greater-than-20% declines over the next several months, using the optimal puts for that.

Comparisons

For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (SPY), the SPDR Dow Jones Industrial Average ETF (DIA) and the Nasdaq 100-tracking ETF PowerShares QQQ Trust ETF (QQQ) against the similar declines. First, a reminder about what optimal puts mean in this context and why I've used 20% as a decline threshold.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones (there's an example of this, with screenshots, in this article about hedging against a US default with optimal puts on TLT).

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary in October 2008:

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

How Costs Are Calculated

To be conservative, Portfolio Armor calculated the costs below based on the ask prices of the optimal put options. In practice, though, an investor may be able to buy some of these put options for less (i.e., at a price between the bid and the ask).

Why There Were No Optimal Puts for LVLT

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with Level 3 Communications (LVLT). As of Friday, the cost of protecting against a greater-than-20% decline in that stock over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for it.

Hedging Costs as of Tuesday's close

The data in the table below is as of Tuesday's close. After the three ETFs listed for comparison purposes, the NYSE stocks are listed in order of their share volume in Tuesday's trading, with the most actively traded stock (MI) listed first; the Nasdaq stocks are listed in a similar order, with the most actively traded Nasdaq stock (SIRI) listed first.

Symbol

Name

Cost of Protection (as % of position value)
  Comparison Index ETFs  

SPY

SPDR S&P 500

1.23%**
DIA SPDR Dow Jones Industrial Avg 1.22%**
QQQ PowerShares QQQ Trust 1.98%**
  NYSE Stocks  
MI New M&I Corporation 5.06%**
BAC Bank of America Corporation 5.91%**
ACN Accenture, plc 2.35%**
F Ford 4.68%**
GE General Electric Company 2.68%**
C Citigroup Inc. 3.43%**
S Sprint Nextel Corporation 8.35%**
PFE Pfizer Inc. 2.31%**
WFC Wells Fargo & Co. 3.55%**
JPM JP Morgan Chase & Co. 3.27%**
  Nasdaq Stocks  
SIRI Sirius XM Radio Inc. 11.0%**
CSCO Cisco Systems, Inc. 3.89%**
MSFT Microsoft Corporation 2.57%**
MU Micron Technologies 12.1%**
INTC Intel Corporation 2.67%**
LVLT Level 3 Communications, Inc. No Optimal Puts At This Threshold
BLUD Immucor, Inc. 0.37%*
ORCL Oracle Corp. 3.12%**
YHOO Yahoo! Inc. 5.55%**
DELL Dell Inc. 4.35%**

*Based on optimal puts expiring in December, 2011.

**Based on optimal puts expiring in January, 2012.

Hedging Update — ETFs

By -

The Chicago Board Options Exchange Market Volatility Index (VIX) dropped 9.91% Wednesday, to close at 17.27. The table below shows the costs, as of Wednesday's close, of hedging 18 of the 20 most actively-traded ETFs against greater-than-20% declines over the next several months, using the optimal puts for that. First, a reminder about why I've used 20% as a decline threshold, what optimal puts mean in this context, and a quick note about why there were no optimal puts for 2 of these ETFs.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web, and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own, and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary in October 2008:

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

How Costs Are Calculated

To be conservative, Portfolio Armor calculated the costs below based on the ask prices of the optimal put options. In practice, though, an investor may be able to buy some of these put options for less (i.e., at a price between the bid and the ask).

Why There Were No Optimal Puts for VXX and TZA

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with iPath S&P 500 VIX Short-Term (VXX) and the Direxion Daily Small Cap Bear 3X (TZA). As of Wednesday's close, the cost of protecting against greater-than-20% declines in those stocks over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for them.

Hedging costs as of Wednesday

The data in the table below is as of Wednesday's close. The ETFs are listed in order of trading volume Wednesday, with the most actively-traded name (SPY) at the top.

Symbol

Name

Cost of Protection (as % of position value)

SPY

SPDR S&P 500

1.17%*
XLF Financial Select Sector SPDR 2.16%*
IWM iShares Russell 2000 Index 2.23%*
QQQ PowerShares QQQ 1.35%*
EEM iShares MSCI Emerging Markets 2.42%*
EWJ iShares MSCI Japan 1.74%*
VXX iPath S&P 500 VIX Short-Term No optimal puts at this threshold
EFA iShares MSCI EAFE Index 2.18%*
FAS Direxion Daily Financial Bull 3X 16.3%**
SLV iShares Silver Trust 5.23%**
SDS ProShares UltraShort S&P 500 2.95%*
VWO Vanguard Emerging Markets 2.91%*
TZA Direxion Daily Small Cap Bear 3x No optimal puts at this threshold
XLE Select Sector SPDR — Energy 1.97%*
FXI iShares FTSE China 25 Index 2.17%**
XLI Industrial Select Sector SPDR 1.66%*
USO United States Oil 3.25%**
SSO ProShares Ultra S&P 500 7.51%*
SMH Semiconductor HOLDRs 4.22%**
XLB Materials Select Sector SPDR 2.06%*

*Based on optimal puts expiring in December, 2011.

**Based on optimal puts expiring in January, 2012.